King Signals Caution on Guidance as BOE Undergoes Policy Revamp

Bank of England Governor Mervyn King said he’s not convinced about the merits of forward guidance because of the risks associated with thresholds such as jobless data that would trigger policy changes.

“What happens if the structural interpretation of a given measured unemployment rate changes,” King said in response to questions at an International Monetary Fund panel discussion in Washington yesterday. “You don’t want to give conditional guidance about a variable where you’re not confident that its structural meaning could change. Because then you’d have to backtrack, and you don’t want to backtrack on a conditional guidance because then you’ve got nothing left.”

King is due to retire at the end of June and his final months have been marked by some of the biggest changes in the BOE’s history. U.K. Chancellor of the Exchequer George Osborne appointed the first foreigner, Mark Carney, to lead the institution, revamped its remit and asked the central bank to review the merits of forward policy guidance.

Carney, currently the Bank of Canada chief and due to take over in July, has previously promoted the benefits of giving investors more insight into the future path of policy.

King said yesterday that while it’s sensible to give guidance in an economic model, there are risks in application. “So I’d be a little bit cautious about it,” he said.

Real Shocks

With the U.K. in the midst of a debate on potential new stimulus measures to revive the economy, King said the main challenge facing monetary policy “is not frameworks or communications, it’s the real factors that have occurred in the crisis and the shocks we’ve experienced.”

“When I talk about the limits to monetary policy, I talk very much about what are the real factors driving weak aggregate demand,” he said. “And I think they are very much related to people adjusting to imbalances. The shocks we have to worry about now are shocks to the banking system, shocks to productivity.”

The BOE held its bond-purchase program at 375 billion pounds ($576 billion) this month, and minutes of the decision to be published in London today will show whether King was defeated for a third month in a push to expand purchases.

Still, in prepared remarks at the IMF event, King said that solving current economic problems will require more than another round of stimulus.

“There are limits on the ability of domestic monetary policy to expand real demand in the face of the need for changes in the real equilibrium of the economy,” he said. “In common with many other countries, our problems also reflect the underlying need to rebalance our economy, requiring a reallocation of resources both within and between nations.”

Inflation Trade-Off

In its overhaul of U.K. monetary policy, the government reworked the BOE’s remit of keeping inflation at 2 percent to give it greater scope to ease policy with inflation above the goal. Inflation was 2.8 percent in March, extending a stretch above the goal that started in 2009.

“The experience of recent years suggests that there may be circumstances in which it is justified to aim off the inflation target for a while in order to moderate the risk of financial crises,” King said.

King also said an economic recovery will be limited until banks have built up their buffers against potential shocks and losses. The BOE’s Financial Policy Committee said last month that U.K. lenders should raise 25 billion pounds of additional capital.

“No matter how much liquidity is thrown at the banking system, lending and the economy will not recover if the banking system is inadequately capitalized and suffering from excessive leverage,” he said. “It is not surprising that the more strongly capitalized banks in the U.K. are expanding lending and the poorly capitalized banks are contracting lending.”

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